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Donald Trump’s win in November was a harbinger of volatility to come.
Now his inauguration is less than two weeks away. So we’ll soon discover how that volatility plays out.
For instance, there’s the impact of his proposed tariffs. Trump reportedly intends to impose tariffs of 10% on global imports into the U.S. Additionally, he could issue a 60% tariff on Chinese goods.
And despite rumors that those numbers could shrink, yesterday Trump posted on Truth Social, “The story in the Washington Post, quoting so-called anonymous sources, which don’t exist, incorrectly states that my tariff policy will be pared back. That is wrong.”
Those tariffs will almost certainly bump up inflation and could set off a trade war.
And that will have ripple effects across the economy… and the Federal Reserve’s interest rate decisions.
So today, let’s look at these factors… and how they will impact our trading this year…
Inflation Has Stopped Falling
Despite cutting rates by 0.25% at the Fed’s December meeting, Chair Jerome Powell moderated interest rate expectations for 2025.
That didn’t surprise me at all…
Inflation has stopped falling. With more inflationary policies on the way, the Fed has wound back the number of potential rate cuts this year from four to two instead.
What’s more, it’s only expecting two 0.25% rate cuts for the two years following as well.
It’s unusual to cut rates when the economy and jobs market are performing strongly – especially when inflation is rising.
So the Fed is in a bind as it tries to control inflation while easing rates back to its “neutral” long-term target (around 3%).
Historically, interest rate decisions are unanimous.
But once again, we saw a dissenting vote among the Fed board members at the December meeting.
And that shows how complex the current landscape is…
Lofty Valuations
Stock valuations are already fully extended. That means the market action will depend on economic releases – and how that data fits into future rate cuts.
It also means that company earnings will come even further into the spotlight…
Ever since the current up leg got underway back in October 2023, investors have fixated on the growth potential of artificial intelligence (AI) stocks.
That pushed the market capitalizations of Microsoft (MSFT), Apple (AAPL), and Nvidia (NVDA) well past $3 trillion.
Compare that to the largest European stocks. The top 40 stocks combined in Germany and France are worth around $1.92 trillion and $2.4 trillion, respectively.
Yet NVDA sold down following its Q3 earnings despite beating earnings per share (EPS) and revenue forecasts. The market is making it clear that that isn’t enough to prop up its price if its growth starts to slow.
Big Tech is deploying billions of dollars in an AI arms race. Yet investors will increasingly scrutinize whether all that spending is converting into company earnings.
So in 2025, we need to keep our wits about us as we trade…
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Turning Volatility Into Profits
As I mentioned at the start, we need to be prepared for an extended period of heightened volatility this year.
And here’s the best way to trade it…
We have to be patient and wait for optimal trade setups. Then we can put volatility to work by buying options when volatility is low but rising.
If you get the trade direction right and volatility increases, that often means a big win for your trading account.
And the bonus of buying options is that you always know your maximum risk before placing your trade. So we can use good risk management by controlling our position sizes.
With Donald Trump readying himself for the White House, you can bet that there will be plenty of surprises ahead.
But that shouldn’t be something to fear…
If we use that volatility to our advantage, I’m confident we will turn 2025 into an opportunity to grow our wealth.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict